Asset Sales: The 10 Percent Solution

Sometimes the best way to get rid of an asset is to keep a piece of it.

Tony Greene was in a bind last October. The CFO of GE Capital ITS Managed Services (GE-ITS) was trying to divest the company’s Disaster Recovery business, which provides offsite computer backup and other services in emergencies. The divestiture was already accounted for in GE’s elaborate annual planning process, so the deal had to be done by year-end. But the high bidder for the unit became intent on “some playing around on due diligence,” says Greene.

With the clock ticking, Greene turned to a second buyout firm, Greenwich, Connecticut-based Generation Partners. Generation quickly came to terms on a price, completed its due diligence in mid-November, and delivered on its promise of a lightning-quick close by December 31. One ingredient in smoothing out the negotiations: GE-ITS’s willingness to retain a minority stake in the unit it was selling.

In 2001, divestitures were really the only part of the M&A world that increased, says Ned Valentine, managing director of investment bank Harris Williams & Co. Indeed, adds Generation Partners co-founder Mark Jennings, “this is the most attractive buyout environment I’ve seen in my career.”

But getting a deal done with today’s hypercautious corporate buyers, or with buyout firms that are strapped for financing, can require substantial sweetening. That’s especially true when speed is critical. Toward that end, keeping a stake in the business you’re selling can have special value. In the GE-ITS case, for example, the company agreed to not only keep an equity stake–”between 10 and 20 percent,” says Greene, although the exact terms of the deal weren’t disclosed–but to also continue selling disaster-recovery services for the divested unit. And GE-ITS itself will also be a client of the disaster-recovery services under the new owners.

Bridging The Valuation Gap

A seller’s agreement to keep a portion of the entity being sold is a common method of greasing the skids for a deal, says Jennings, who believes “you’ll see much more of it in this environment.” At GE, that already seems to be the case. Just this June, it sold its Global Exchange Services E-commerce company to buyout firm Francisco Partners of Menlo Park, California, but kept a 10 percent stake in the company.

One reason for retaining an equity stake is as a sort of “embarrassment insurance,” according to Jennings. Were the buyer to turn its new unit into a star, or to make a killing selling it a few years later, the seller would at least be able to claim some benefit from the turnaround.

But in today’s economy, the motivation often is more pragmatic. “If the company that is selling isn’t cash-strapped and the buyer can only come up with a certain amount of cash, retaining an equity stake is a great way to bridge the valuation gap,” explains Jennings.

Buyout firms still have plenty of cash–as much as $120 billion in unspent private equity, estimates David Barnes, a director at investment bank Houlihan Lokey Howard & Zukin. But they also typically borrow about 60 percent of the purchase price. “If it’s not an asset-laden purchase, they are going to struggle to get financing,” he says. Sellers can help reduce that leverage–and cut the time the buyer spends haggling with banks–by holding on to a slice of equity.

Still, keeping a piece for the potential of an upside also involves retaining the risk of a downdraft, notes Mark Sirower, who leads the M&A practice at The Boston Consulting Group in New York. “You could argue that [doing so] is a good-faith gesture,” if such terms must be hammered out to seal the deal, he says. “But if you have the option of getting all the money up front versus retaining equity, you might as well take the money.”

Tim Reason (timreason@cfo.com) is a staff writer at CFO.

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